Institutional herding, credit rating and overreaction in stock price

Abstract We examine institutional investors’ herding behavior around credit rating changes. We find that institutions herd into stocks with recent rating upgrades and herd out of stocks with recent downgrades, with a stronger effect for rating downgrades, large rating changes, and high‐risk firms. These results remain after controlling for earnings surprises and analysts’ recommendation revisions. Results from price impact tests and cross‐sectional analyses by firm‐ and institution‐type suggest that the institutional herding following credit rating changes is mainly an overreaction to rating downgrades and is more consistent with reputational herding.